Using Cost Information in Manufacturing Decisions

Nov. 21, 2013
When manufacturing personnel are involved in making decisions with cost information, things often get a bit murky.

Accountants can explain the cost figures—where they come from, how the calculations are made, and how they connect to and comply with the financial statements—but somehow it doesn’t connect to what you know about your manufacturing operations. This is because no costing systems can capture every characteristic of a resource. And resources are the source of all costs.

Consider some principles and concepts that are often overlooked when using cost information for decision-making inside the organization. The primary principle for using cost information for managerial decisions is analogy—the logical use of information based on facts. Cost figures are not facts; they are representations of the use of resources. The facts are the resources and processes that cost figures represent.

The critical factor driving how accurately cost figures represent resources and processes is whether the model is focused on representing them or just meeting a set of standards (typically accounting standards). Most accounting-driven cost systems are focused on meeting accounting standards.

Four key concepts need to be considered when using cost information for decisions. The first concept is avoidability. When a decision changes the way you use resources (and nearly all do), some costs are unavoidable, such as depreciation on equipment you will use less. And some costs are avoidable, such as temporary employees during a slowdown. Do not confuse avoidability with fixed and variable cost labels; these are often very loosely categorized. Resources and their costs should be examined separately for avoidability in the face of a decision.

The second concept is divisibility, which links costs to resources. Divisibility defines whether a resource can be associated in its entirety with the change in output resulting from a decision. You can’t reduce costs by shifting them in the organization. For example, if you save 1,000 hours in maintenance time, is a cash savings created? This depends on whether you can cut maintenance technician hours. Improving processes is always a good thing. It creates flexibility, and the maintenance technician’s hours can be applied to other valuable activities. But if you can’t eliminate the hours entirely, the technician is not divisible and his costs not avoidable. Thus, no cash savings will result.

The third concept is interdependence. Cost information doesn’t automatically capture the fact that a decision to use resources to achieve one objective will affect the resources required to achieve other objectives. For example, opening a new production line will drain resources (experienced people, maintenance effort, etc.) from existing production lines, and increase costs for existing products.

The fourth concept is interchangeability. Cost models group resources; however, similar resources are not identical. For example, you could have two identical machines, but they are in different locations and require more material movement; or one machine could break down more often. People are not instantly interchangeable even if they have the same job experience and qualifications because of variations in performance, work ethic and many other factors.

Finally, you have to examine how constrained your decision is. Can you give unbiased consideration of all resource application alternatives? Is there congruence between individual manager goals/incentives and enterprise objectives? Often a decision is constrained by short-term negative financial statement impacts and/or individual performance measures tied to financial statement metrics, even when the long-term economic impact for the company is positive.

Costing systems focused on internal decisions (rather than financial reporting) can provide more insight into these information gaps, but can’t eliminate them. Financial outcomes are always based on resource application decisions in the end. Don’t let finance forget what constitutes the facts about your operations.

>> Larry White, CMA, CFM, CPA, CGFM, [email protected], is the Executive Director of the Resource Consumption Accounting Institute (, which trains and advocates for improved cost information connecting operations to business performance.

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